Allaire Corp. v. Okumus

• Decision Date: 05 January 2006
• Docket Number: Docket No. 04-2149-CV.
• Citation: 433 F.3d 248
• Parties: ALLAIRE CORPORATION, Plaintiff-Appellant, v. Ahmet H. OKUMUS, Okumus Capital, LLC, Okumus Opportunity Fund, Ltd., Okumus Technology Value Fund, Ltd., Okumus Advisors, LLC, Okumus Opportunity Partners, LP, Okumus Technology Advisors, LLC, and Okumus Technology Value Partners, LP, Defendants-Appellees.
• Court: U.S. Court of Appeals — Second Circuit

433 F.3d 248

ALLAIRE CORPORATION, Plaintiff-Appellant, v. Ahmet H. OKUMUS, Okumus Capital, LLC, Okumus Opportunity Fund, Ltd., Okumus Technology Value Fund, Ltd., Okumus Advisors, LLC, Okumus Opportunity Partners, LP, Okumus Technology Advisors, LLC, and Okumus Technology Value Partners, LP, Defendants-Appellees.

Docket No. 04-2149-CV.

United States Court of Appeals, Second Circuit.

Argued: February 15, 2005.

Decided: January 5, 2006.

John H. Henn, Foley Hoag, LLP (Steven W. Phillips, of counsel), Boston, MA, for Plaintiff-Appellant.

Jonathan Honig, Feder Kaszovitz, Isaacson, Weber, Skala, Bass & Rhine, LLP, New York, NY, for Defendants-Appellees.

Before: KEARSE, SACK, and SOTOMAYOR, Circuit Judges.

BACKGROUND

SACK, Circuit Judge.

Plaintiff Allaire Corporation ("Allaire") is a Delaware corporation.¹ At all relevant times, Allaire's common stock was traded on the NASDAQ National Market. Defendant Ahmet H. Okumus directly or indirectly controls each of the other defendants (defendants collectively, "Okumus").

According to Allaire's complaint, Okumus wrote (sold) a set of call options on Allaire common stock on November 17, 2000. Three days later, on November 20, 2000, Okumus allegedly acquired a sufficient number of shares to become a statutory insider for purposes of section 16(b). On December 16, 2000, the November 17 calls expired unexercised. On January 16, 2001, Okumus wrote a second set of calls on Allaire common stock. Okumus allegedly remained a statutory insider throughout this period.

On March 18, 2003, Allaire brought suit against Okumus in the United States District Court for the Southern District of New York alleging that Okumus was a "statutory insider" who was liable to Allaire under section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b) (1994),² for making short-swing trades in Allaire common stock or its equivalent. Relying on rules promulgated by the Securities and Exchange Commission ("SEC") that govern section 16(b)'s applicability to transactions in derivative securities, Allaire alleges that the expiration of the November calls in December constituted a "purchase" of Allaire stock, and that the writing of a new set of calls in January constituted a "sale" of Allaire stock. Allaire argues that these two transactions ought to be matched with one another as a basis for holding Okumus liable under section 16(b) for the profits Okumus generated from them. See Rule 16a-1, 17 C.F.R. § 240.16a-1; Rule 16b-6, 17 C.F.R. § 240.16b-6.

The district court (Thomas P. Griesa, Judge) dismissed the action pursuant to Federal Rule of Civil Procedure 12(b)(6) for failure to state a claim upon which relief can be granted. Allaire Corp. v. Okumus, No. 03 Civ.1901, 2004 WL 719178, 2004 U.S. Dist. LEXIS 5576 (S.D.N.Y. Mar. 31, 2004). The court concluded that the expiration of the first set of calls was not a purchase under SEC Rule 16b-6 and that the plaintiff had therefore failed to state a claim under section 16(b).

Allaire appeals.

DISCUSSION

I. Standard of Review

"We review de novo the grant of a motion to dismiss under Rule 12(b)(6), accepting as true the factual allegations in the complaint and drawing all inferences in the plaintiff's favor." Scutti Enters., LLC. v. Park Place Entm't. Corp., 322 F.3d 211, 214 (2d Cir.2003). A complaint may not be dismissed under the Rule "unless it appears beyond doubt, even when the complaint is liberally construed, that the plaintiff can prove no set of facts which would entitle him to relief." Id. (internal quotation marks and citation omitted).

II. Section 16(b)

Section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b), provides that statutory insiders of a corporation will forfeit any profits they make as a result of their "short-swing" trades in the equity securities of the corporation. It reads:

For the purpose of preventing the unfair use of information which may have been obtained by such beneficial owner . . . by reason of his relationship to the issuer, any profit realized by him from any purchase and sale, or any sale and purchase, of any equity security of such issuer (other than an exempted security) within any period of less than six months . . . shall inure to and be recoverable by the issuer, irrespective of any intention on the part of such beneficial owner . . . in entering into such transaction of holding the security purchased or of not repurchasing the security sold for a period exceeding six months. . . . This subsection shall not be construed to cover any transaction where such beneficial owner was not such both at the time of the purchase and sale, or the sale and purchase, of the security involved, or any transaction or transactions which the Commission by rules and regulations may exempt as not comprehended within the purpose of this subsection.

15 U.S.C. § 78p(b) (1994).

Section 16(a) defines "insider" for these purposes as any person "who is directly or indirectly the beneficial owner of more than 10 per centum of any class of any equity security (other than an exempted security) which is registered pursuant to § 781 of this title." 15 U.S.C. § 78p(a) (1994). A "short swing" trade is a sale and a purchase of such equity security made within six months of each other. See 15 U.S.C. § 78p(b). Under the facts as alleged by Allaire, Okumus was a statutory insider from November 20, 2000, through February 16, 2001, when he divested himself of all his equity interest in Allaire.

The SEC has, by regulation, defined the term "equity security" to mean "any equity security or derivative security relating to an issuer, whether or not issued by that issuer." 17 C.F.R. § 240.16a-1(d). Any purchase (or its equivalent) of an equity security in a corporation may be matched with any sale (or its equivalent) of such a security, provided the transactions occur within six months of each other. Magma Power Co. v. Dow Chem. Co., 136 F.3d 316, 320 (2d Cir.1998). "The statutory definitions of `purchase' and `sale' are broad and, at least arguably, reach many transactions not ordinarily deemed a sale or purchase." Kern County Land Co. v. Occidental Petroleum Corp., 411 U.S. 582, 593-94, 93 S.Ct. 1736, 36 L.Ed.2d 503 (1973).

III. Rule 16b-6(a)

In 1991, the SEC issued regulations to govern the application of section 16(b) to derivative securities.³ See Ownership Reports and Trading by Officers, Directors and Principal Security Holders, Exchange Act Release No. 34-28869, Investment Company Act Release No. 35-25254, 56 Fed.Reg. 7242-01, 7248 (Feb. 21, 1991) ("[T]he Commission is adopting a comprehensive regulatory framework, in order to effect the purposes of section 16 and to address the proliferation of derivative securities and the popularity of exchange-traded options."). Rule 16b-6(a) provides in relevant part:

The establishment of or increase in a call equivalent position or liquidation of or decrease in a put equivalent position shall be deemed a purchase of the underlying security for purposes of section 16(b) of the Act, and the establishment of or increase in a put equivalent position or liquidation of or decrease in a call equivalent position shall be deemed a sale of the underlying securities for purposes of section 16(b) of the Act . . . .

Id., 17 C.F.R. § 240.16b-6(a). The principal issue before us on appeal is whether, under Rule 16b-6(a), the expiration of a short call option is a purchase, thereby exposing its insider/writer to section 16(b) liability if within six months after that expiration he or she also wrote (sold) another such call option.

Allaire's reading of Rule 16b-6(a) would require an affirmative answer to that question. Allaire points out that another section of the applicable regulations defines the term "put equivalent position" as "a derivative security position that increases in value as the value of the underlying equity decreases, including, but not limited to, a long put option and a short call option position." 17 C.F.R. § 240.16a-1(h). A party establishes a short call option position by writing a call option. In doing so, the writer obligates him- or herself to sell the security to the holder of the option (who is then in a "long" position with respect to the securities) at the agreed-upon "strike price" whenever the holder demands it, except no later than the date the option expires. The value of the writer's "derivative security position" does indeed "increase[] in value as the value of the underlying equity decreases," id., because the likelihood that the writer will be able to pocket the premium the purchaser paid him or her for the right to purchase the shares without the purchaser ever exercising that right increases as the value of the underlying equity decreases.⁴ If the option does expire unexercised — presumably because the market price was below the strike price when the purchaser might otherwise have executed it — the writer's obligation to sell the security ceases, terminating his or her put equivalent position. Such an expiration, Allaire urges us to conclude, represents a "liquidation of or decrease in a put equivalent position" and is therefore a "purchase" under Rule 16b-6(a). As a purchase, it must be matched with the set of calls Okumus wrote on Allaire's stock on January 16, 2001, which is a "sale." Allaire argues that there is thus a purchase and a sale sufficient to give rise to liability under section 16(b).

Although this reading of Rule 16b-6(a) is not implausible, it appears to contradict the statutory purpose of holding traders liable only for those transactions in which they can exploit their inside information for their own profit. We have previously held that "the exercise of a fixed-price option is a non-event for 16(b) purposes . . . because the insider by then is already bound by the terms of the option, [so] the potential for abuse of inside information is minimal." Magma Power, 136 F.3d at 322. A fortiori, when the option is written by the...